Alleane West knew her four sons had potential. But growing up in Mobile, Ala., they had few educational options and plenty of opportunity to get off track. When she and her oldest son, Nick, discovered the state’s tax credit scholarship program, it felt like a lifeline.
“It was a relief that nobody would understand unless you know you’re a single mom with boys, trying to not make them a statistic,” West said in a video produced by the Alabama Opportunity Scholarship Fund.
Through one of the fund’s scholarships, Nick attended McGill-Toolen Catholic High School, where his classmates unanimously voted him most likely to succeed. He accepted a full ride scholarship to the University of Alabama in Huntsville and hopes one day to join the FBI.
This school year, 250,000 students like Nick are attending private schools on scholarships funded by 23 tax credit programs in 18 states. But that number could drop dramatically next year amid the unintended fallout of a fight between Republican lawmakers in Washington and Democrats in high tax states.
Under the Tax Cuts and Jobs Act, federal deductions for state and local taxes are capped at $10,000. That limit closed a loophole in the federal tax code that allowed residents in high-tax states to significantly reduce their overall tax bill. According to a Heritage Foundation analysis, the “average” millionaire in New York or California deducted more than $450,000 worth of state and local taxes under the old rules, while the average millionaire in Texas and Florida deducted only about $75,000.
The $10,000 deduction cap outraged lawmakers in New York, New Jersey, and Connecticut, who faced the prospect of constituents feeling the full brunt of their state tax burden. To solve the problem, they came up with a creative solution: state-run charities that pay for government services. Residents who “donate” to those charities get tax credits to offset their local tax bills. They can then write off those so-called “donations” on their federal tax returns.
Leslie Hiner, vice president of legal affairs for EdChoice, a national organization that advocates for school choice programs, called the workaround “a tax scheme to try to get out of paying federal taxes.”
To shut down that new loophole, the U.S. Treasury Department issued a rule limiting state tax credits in exchange for any charitable donations, including to things like the Alabama Opportunity Scholarship Fund. That meant it applied to tax credit scholarships programs as well. Hiner described the rule as taking a sledgehammer to a nail: “They had a very specific problem, but in correcting the very specific problem, they issued a very broad rule that swept in a whole lot of other people, a lot of other nonprofits that were no part of any of the schemes being created by those states.”
Lesley Searcy, who heads the Alabama Opportunity Scholarship Fund, worries the new rule will slow donations.
“We have over 600 individual donors that support our program,” she said. “And there is great concern that the program will suffer if the contributions are not sustained.”
Searcy’s group funds scholarships for 1,600 students, with 20,000 more on a waiting list. All the families are low-income, with the average family of four making just $26,000 a year. Without their scholarships, the students would be forced back into the local schools they so desperately wanted to leave.
“Right now all of our students are funded for this current school year, but we’ve got to have clarity, and we desperately need that carve-out so that we can provide assurance for our students for the next school year that they’ll still have scholarships,” she said.
The Treasury Department is taking public comments on the new rule until Oct. 11 and could still come up with a solution. But even if it does, school choice advocates now realize tax-credit scholarships have a weakness: their dependence on the federal tax code.
“I think now is the time for everyone to reconsider these programs in terms of how to make these existing programs stronger or how can we establish a different type of program that would have a more reliable funding stream,” Hiner said.